Will IRS Really Settle Tax Debt for Pennies on the Dollar?

The latest radio commercials claim that if you owe the IRS $10,000 or more in back taxes or delinquent tax, that there are government programs that will help you settle that tax debt for pennies on the dollar. They go on to say that, with this company’s help, of course, you can make you tax debts go away, including fees and penalties.

Sound too good to be true?

It probably is.

How IRS Settles Delinquent Tax Debts

In many ways, the IRS is just like any other creditor. If someone owes them money, then they want to get paid that money. However, in many other ways, the IRS is unlike any other creditor out there.

For most companies, collecting on a delinquent debt is a cost-reward calculation. The amount of possible debt recovery is compared to the cost of getting that money. For a very large debt from someone with the means to pay it, it is worth it to engage lawyers and go to court to seize assets and garnish wages. For smaller debts, or for debtors with no assets, the cost of collecting the debt isn’t worth it. There comes a point where trying to collect the debt simply costs too much. Even a big corporation with a debt collecting department has a maximum amount of collection activities it can undertake. Is it worth it to hire more employees to keep going after old, low value debts that the debtor has no intention of ever repaying?

Instead, the company writes the debt off, which allows it to take a tax deduction for the loss. Much like an IRS contribution you might make, this reduces the overall expense. For example, if a company pays an effective tax rate of 25 percent and it writes off a $10,000 debt, it saves $2,500 on taxes (not exactly, but close enough for this discussion). Thus, overall, the company is only out $7,500. It may recover another small amount of that debt by selling the debt to a collection agency. In the end, the company loses maybe $6K or $7K and moves on.

The IRS works in a similar manner, but with two major differences. First, the IRS doesn’t get to write off debts for a tax deduction. It is the government. It doesn’t pay taxes and it doesn’t get deductions. Therefore, it can’t reduce its loss by giving up on collecting a tax debt.

Second, the IRS doesn’t have to actively try and collect your debt. Unlike many other debts, your tax liability won’t go away. If you don’t pay your taxes, they’ll just keep adding up. Tax debts generally cannot be discharged in bankruptcy and the IRS doesn’t have to try and keep track of you either. You, and your employer, and your bank, and so on, update the IRS constantly with your whereabouts and financial status. If you have a tax refund coming, they can just keep it. If you have a state tax refund, they’ll just send it to Uncle Sam, no court orders, no lawyers, no extra expenses. Ever notice that checkbox on tax forms, that asks if you’re subject to backup withholding? That’s another way that the IRS can just sneak in and get a little more payment from you as you go through life, whether its from your investments, your business, or somewhere else where funds can be intercepted.

The truth is that for the average American who owes back taxes, the IRS will not settle with you. For most people that means they’ll just wait and keep taking your tax refunds. If you owe a lot and have plenty of income, they’ll probably go through through the steps to garnish your wages. Eventually they’ll make you subject to backup withholding. Then, they’ll wait. If it takes 10 years to get all its money back, it doesn’t matter. Neither the government or the IRS are going anywhere.

When Does the IRS Settle Tax Debts?

So, when does the IRS settle back taxes disputes for way less than is actually owed?

The answer usually involves a failed business, someone whose earnings were once very large, but won’t ever be again, or situations involving real estate, investments, or mineral rights.

Consider someone who gets left some land in a will. They sell the land, and maybe the mineral rights. Maybe they get a million dollars. Maybe they don’t fully understand the tax implications. They spend the million dollars on something like vacations, college for their children, and a few investments that don’t work out. When the IRS catches up to them they owe $250,000 in back taxes. Now, if they bought something with the money, like a house, or other property, the IRS could try and seize those assets. But, in this case, they didn’t end up with any sizable assets.

Now what?

If this is an average family, earning an average income, paying average taxes, there is no way the IRS is ever going to collect $250,000 from this family even if they intercept every tax refund, dividend check, and wage garnishment they can for the rest of their lives. In this case, the IRS is probably very willing to settle for pennies on the dollar. The actual amount is going to be dependent on what assets they do have and what income they do have. The IRS might consider taking a $25,000 payment, particularly if that is most of the family’s assets. After all, what is the alternative?

That being said, there is no rule against asking the IRS to settle your back taxes for a lower amount. Chances are the various firms behind these offers charge a flat, up-front, fee to produce this offer. Whether the IRS accepts it or not, is of no concern to them. Instead, they make their money by charging you $300 and then using a computer to automatically generate an Offer of Compromise to send to the IRS. Their only expense is the stamp (and ignoring your upset phone call).

Before you contact one of these firms consider first using the IRS Offer in Compromise pre-qualifier to see how likely they are to accept your offer. Then, be very clear about what the fee is, and what EXACTLY you get for that fee. The way to keep this IRS back tax settlement scam going for a company is to charge you one fee to file the compromise, then tell you that you are very close to getting one, and then charging you another fee to file another offer, or an appeal of some sort. When it’s all said and done, you’ll still owe most, or all, of your taxes, and you’ll be out the few hundred dollars you paid to the company to get you relief from the IRS.

If you want to stop a garnishment, just file the form for a payment plan with the IRS. That puts everything on hold while they process that form first.

If you do want to try to make an offer for compromise with the IRS, remember you can do it for free using the forms in this booklet directly from the IRS.